News about the upcoming Snapchat IPO could take TWTR stock even higher after yesterday's pop.

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Shares of San Francisco, California-based Twitter Inc (NYSE:TWTR)have suddenly shot up over the last 5 days. And surprisingly, there's no talk or speculation about a buyout this time around. As it appears, a combination of technical triggers and news about the upcoming Snapchat IPO seem to have sparked off the rally in TWTR stock. The consistent decline in short interest might also have contributed to the surge in positive sentiment, albeit in a small way. And by the looks of it, Twitter stock may well be headed even higher in the coming days, if Snapchat does manage to snap up a $25 billion valuation. Investors might also want to keep an eye on shares of Menlo Park-based Facebook Inc (NASDAQ:FB), which could be the biggest beneficiary of the Snapchat IPO.

Snapchat IPO valuations make Twitter look dirt cheap

Much before news emerged about 12 hours ago that Snapchat's parent company Snap Inc had actually filed for its IPO, there were several credible sources like The Economist, which reported that the company would complete its filing this week. Understandably, the sentiment seems to have turned positive for Twitter. Now here's a company that has a fraction of Twitter's revenue, and by its own admission, may never be profitable. Yet, Snap Inc could end up being valued at as much as $25 billion. Coincidentally, that's exactly twice as much as Twitter's market cap of $12.4 billion, which makes Twitter look ridiculously cheap.

Now we do understand that some of this is just common language used by a lot of companies in their IPO filings, to ensure that nobody gets to blame them for incinerating the spoils (funds raised) from their outlandishly valued IPOs. However, As Shira Ovide of Bloomberg Gadfly recently highlighted in her post, Snapchat does have a genuine and unique problem. And the company may actually mean what their saying, when they say:

"We have incurred operating losses in the past, expect to incur operating losses in the future, and may never achieve or maintain profitability,"

The problem with Snapchat is that, it's not the operating costs that outweigh the revenue. It's the cost of revenue. Snapchat's cost of revenue exceeded the company's revenue for 2016. And while Snapchat's gross margin did turn positive in the second half of 2016, it did so only marginally. Snapchat's gross margin of 7.4% is dwarfed by Twitter's 65.4%. Ovide highlights some important points with reference to Snapchat's business model, which could eventually prevent it from turning a serious profit:

"Snapchat is unique in this regard compared with other internet companies. It pays for server costs from Google's cloud-computing operation, which makes the financial burden of every snap and story hit the company's expense line even before the company can generate ad revenue from them."

Even if we were to keep that aside for a moment, the valuations just don't make sense. Snapchat raked in about $404 million in 2016. Given that the company could be valued at as much as $25 billion, that translates to a Price to Sales ratio of about 62, which is just insane. Even if you look at the one year forward P/S, assuming Snapchat does meet estimates of $1 billion in revenue for 2017, the forward P/S comes in at 25 times 1 year forward sales. If that is indeed the price investors are willing to pay for Snapchat shares, then Twitter deserves better valuations without a doubt. Twitter made over $2.5 billion over the last twelve months, and currently trades at a P/S ratio of under 5.

Snapchat has relatively impressive user numbers, but for how long?

What Snapchat does have going for it, is it's reasonably sized (compared to Twitter) base of Daily Active Users or DAUs. Snapchat has 161 million DAUs, and while Twitter doesn't divulge its DAU count, given that it has just over 300 million Monthly Active Users (MAUs), it doesn't really matter how many DAUs the platform attracts. Even based on these numbers, it's pretty evident that Snapchat's DAU base is quite impressive on a relative basis.

While Snapchat does have that advantage, the question is, for how long? Reports suggest that Snapchat's DAU growth slowed significantly after the Facebook launched Instagram Stories, a feature that apes one of Snapchat's hitherto unique selling propositions. And given Instagram's significantly larger user base, it might not take the platform too much of an effort to at least partially eat into Snapchat's existing user base if it starts to ape other features offered by the service.

To illustrate, Instagram Stories reportedly has about 150 million DAUs, and that's primarily because it has 400 million DAUs, all of whom they can expose to features they copy from Snapchat, which on the other hand, has to accumulate new users in the first place. For those who justify Snapchat's valuations using it's current growth rate, it might be worth noting that Twitter had a similar narrative, which eventually went awry in the absence of user growth. And there's no guarantee that the same won't happen with Snapchat, or any other companies in this space.

Summing it up, Twitter and Facebook could ride this unicorn. Keep an eye on how the Snapchat IPO unfolds. If the company is indeed valued at $25 billion, you might want to buy into stocks like Facebook and Twitter. Clearly, they offer much more value. While Facebook is in a different league, and we think FB stock is headed higher, apparently, Twitter isn't all that bad either. It has plateaued, in terms of user growth, and arguably in terms of top line growth as well. However, Twitter's metrics probably won't get too much worse. At its current valuations, it offers way better (relatively) fundamentals at a fraction of the price. The upcoming Snapchat IPO could well be a dream come true for Jack Dorsey and Twitter.

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